There are many ways to measure performance when you're investing in stocks.
Many investors employ the most basic way by noting if the stock's current price is higher or lower than the purchase price.
The price difference is certainly an important consideration, however it doesn't tell you the whole picture.
You need to answer a more important question in determining whether a stock in performing well: Compared to what?
Most investors set price goals for a stock, however if you don't evaluate a stock's performance in an appropriate context, you may be missing the bigger picture.
A stock does not exist in a vacuum. Like the company it represents, stocks are influenced by a number of factors including;
- Economy
- Market competition
- Global influences
In other factors that may be peculiar to this particular industry
The mutual fund industry likes to compare performance to market standards, such as the S&P 500, the Dow or the NASDAQ. Fund managers use these indexes to determine whether they have "beat the market" or not for the year.
For the individual stock investors it is important to measure performance in a narrower context, since no company truly represents the whole market.
The best place to start is to compare the stock's performance to those stocks of its peers.
You want to compare IBM to Hewlett-Packard, not US steel. However, many companies are very diversified in their business lines, especially the surviving companies from mergers that were so common during the conglomerate mania of a few decades ago.
Fortunately, you can find a great deal of information about a company and its competitors very easily.
Here is where stock sectors become important. Stock sectors group similar companies under a broad categories such as transportation, technology, healthcare and so on.
This information is readily available over a number of financial sites. I like the stock sector reports on Yahoo! Finance.
Sectors are fairly broad, so it is important to drill down deeper. Under sector is an "industry" category that narrows the groupings even more.
For example, if you look at IBM under the Yahoo! Finance link above, you will see a link to "Components" in the left-hand navigation. That link takes you to a page that shows the sector (Technology) and the industry (Diversified Computer Systems) for IBM.
If you own a technology stock like IBM, you can compare how it has performed to the industry and sector. This tells you how your stock is doing compared to other companies in the same industry.
Comparing stocks
If you click on the "Competitors" link, you are taken to a page that compares the stock to several direct competitors.
You can look at a number of indicators, including price to see how your stock is doing compared to its industry group. However, industry groups are very broad so the comparison to an individual company is somewhat strained.
By clicking on the industry sector, you can see the sub-sectors in each group. For example, under the technology sector, you will find a lengthy list of sub-sectors, such as communication equipment, Internet software & services, wireless communications and so on.
This lets you compare your stock more specifically with a group of similar companies. If you click on a sub-sector, Yahoo gives you a list of the companies that make up the sub-sector.
This lets you confirm you are looking in the correct sub-sectors (your company should be listed) and lets you compare your stock's performance with direct competitors.
With these tools you can answer the "compared to what" question. If your stock is up 10%, that may seem like a good return. However, if its direct competitors are up 25%, you might ask yourself if you own the wrong stock.
If any case, the ability to compare your stock to broad and narrow measurements helps you decide how well it is really performing.
